You Can Get Student Loans Forgiven in Bankruptcy, but It’s Far From Easy

Conventional wisdom once held that it was almost impossible for debtors to get off the hook for student loans, even after they declared bankruptcy. That thinking was challenged by a 2012 paper in the American Bankruptcy Law Journal that showed that a high percentage of those who sought a release from their student debt were successful. A decision handed down last month in U.S. District Court in Alabama shows that success rates aside, the standards for winning a discharge (legalese for having your loan obligation canceled) are plenty high.

In the Alabama case (subscription required), the U.S. Department of Education sought to overturn a bankruptcy court’s decision to discharge $82,000 in student loans made to a former Auburn University sociology major currently working in business development at a staffing company. In its appeal, the government argued that the lower court erred in determining that the debtor met the standard of “undue hardship” needed to discharge student loans.

For the most part, bankruptcy courts have adopted something called the Brunner test for such cases, requiring a debtor to meet three requirements: The student loans must prevent her from maintaining a “minimal” standard of living, she needs to demonstrate a good-faith effort to maximize income and limit expenses, and she must show that her hardship is likely to continue for a “significant portion of the repayment period.”

Traditionally, that standard has been considered almost impossible to meet because debtors effectively have to prove they’re not only destitute, but also that they’ll stay that way for most of the loan’s life. Writing in American Bankruptcy Law Journal in 2012, Princeton University doctoral candidate Jason Iuliano estimated that 39 percent of debtors seeking to discharge student loans in 2007 were at least partially successful. Two other findings from Iuliano’s study: Only a tiny fraction—217 out of more than 169,000 of eligible bankruptcy filers in his sample—sought student loan discharges. But another 69,000 filers probably had good cases for relief.

In light of those numbers, it’s worth revisiting the Alabama case. The debtor makes $10.50 an hour at her current job and also receives food stamps—she’s sought higher-paying work but “lacked a marketable degree,” according to the bankruptcy court’s opinion. Her monthly expenses, including child care for her two children, are $2,495—$545 more than her income.

Those facts didn’t stop the Department of Education from appealing the original decision to discharge the loans. (In fairness to the government, it wanted the debtor to enter an income-based repayment program in which she would have paid nothing based on her current salary.) That may serve as a cautionary tale for anyone who thinks winning a student loan discharge will be easy—and, for that matter, anyone considering a sociology degree.